Why Invest In Certificates of Deposit (CD) When Rates Are So Low

Porsche 911 Carrera 2013

I love CDs because they let me rest easy. Roughly 30% of my net worth is in CDs and other stable instruments currently yielding a blended rate of around 3.75%. Even with rates so low, if I invest $250,000 at 2.3% I still earn $479 a month, which is a very nice chunk of guaranteed change for an early retiree.

What’s interesting to note is that as of February 4, 2013, the 10-year yield has risen to around 1.95% while a 7-year CD is yielding 2.1%. In other words, there is an arbitrage opportunity here because one can invest in a CD with a higher yield and at a shorter duration period.

It is rare for a CD to yield a higher rate and have a shorter duration than the 10-year Treasury. Whenever this happen, I am an aggressive buyer. 5-year CD yields at Ally Bank are currently at 1.59%, which is also higher than current government yields.

REASONS WHY I INVEST IN CDs DESPITE LOW RATES

* As long as I’m making money, I will have a steady inflow of excess cash given I save over 50% of my after tax income a month. If rates go up, I’m just going to invest in a higher yielding CD for the longest duration possible. It’s not like I’m one and done. The CD ladder is forever growing so long as I have income.

* Accrued interest is accessible. In the event that I no longer have income and no longer have any savings, all the accrued interest earned from my CDs can be withdrawn and used penalty free.

* CDs are 100% backed by the FDIC up to $250,000 per person on the account. I don’t have to worry about some corporate CEO scandal or competitive threats blowing up my specific stock. As a result, I can focus on more productive things.

* CDs offer a much higher interest yield than money markets. People complain about sub 2% CD interest rates when they are in effect 5-10X higher than money market interest rates at 0.2%-0.3%. Money markets are the real travesty! I’ve left the majority of my money in a money market for two months earning 0.3% a year which didn’t feel optimal.

* Diversification is important. Throwing 30% of my recurring savings in CDs is prudent, leaving me with 70% to invest in the stock market, real estate market, or in myself. It was fun buying Facebook for a 30% gain. But I’m under no delusion I will continue to get lucky.  I also keep my single stock investments to around $25,000 due to my risk metrics. I’m unwilling to invest in Treasuries because of how high they’ve risen already and their lower rates than CDs.

* Passive guaranteed income is becoming more valuable. Right now I’ve got about $2,800 a month in CD interest income.  If I threw the entire $250,000 in an Ally CD, my CD income would rise to ~$3,000 a month. With $3,000 a month in guaranteed income for the next several years, I know I will not be begging on the streets if I fail at entrepreneurship. Having the CD interest income safety net helps give me the confidence to create my own luck.

* I’m not greedy. Everybody says that inflation will eat away at my earnings. True, but my absolute capital is still going up with CDs. I’d rather make 1.59% on a CD than lose 5% in the stock market. Interest rates and inflation are tied together. You don’t have high inflation without high interest rates and vice versa. Once you build your nut to live off, you will do everything you can to perserve it because it took so long to build.

* Focusing on my X Factor. Given I’ve got the energy right now, I’m all about focusing on my X Factor. The X Factor is in all of us.  We just have to unleash the beast. Often times, we can’t because we’re worried about school, money, family, etc.  By putting my money in CDs, I just don’t worry about the funds at all anymore. I can then focus more of my time on my online work, my upcoming book, and other projects that provide MUCH GREATER returns than everything else!

RATES WILL STAY LOW FOR A WHILE

It’s important to get over the fact that the absolute rates are low and look at things relative to other things. When I was investing in 4.5% CDs, people were laughing at me for being so conservative. Well they sure as hell weren’t laughing after they lost 30-50% of the value in the stock market! And they sure as hell weren’t laughing when they lost their jobs due to the implosion in corporate earnings.

We are in an environment of incredible volatility and risk. I’d much rather make 1.59% on my money than 0.1% in a money market account. Furthermore, I’d much rather make 1.73% on my money than LOSE money in the stock markets. Everything is always relative and rates are low because borrowing costs are also low.

If you are a prodigious saver, are willing to keep your money safe for a set duration of time while earning an interest rate above the current risk free rate 10 Year Treausry, and are concurrently investing in other more aggressive instruments, I recommend diversifying your capital into a 5-year CD account or longer duration. The fact that a 5-year CD is yielding about the same as the 10-year Treasury yield is unheard of.

Putting 30% of my net worth in long duration CDs has been one of the absolute best things I could have done for the past 13 years.   $100,000 invested 7 years ago at a 4% compounded rate of return is now worth 32% more. I will continue to invest 30 cents for every single dollar I earn in CDs for as long as I make money. I sleep well every night knowing my money will always be there and is getting the best relative return.

Recommended Actions For Increasing Your Wealth

* Manage Your Finances In One Place: Get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing, when my CDs are expiring, and how my net worth is progressing. I can even keep track of my spending. The best feature is the 401K Fee Analyzer which is saving me $1,000+ a year in portfolio fees. There is no better free tool online that I’ve found today. It takes a minute to sign up.

* High Interest Savings Account: I recommend EverBank with a 1.11% yield given 7-year CD rates are at 2%. A 1.10% savings rate where you can freely access your money without penalty is a no brainer compared to locking your money up for 5-10 years at only 2%. Online banking is the best place to park your cash and it’s very convenient to deposit or withdraw money. Don’t let traditional banks get away with paying you nothing in interest as you fall way behind due to inflation!

Photo: 2013 Porsche 911 Carrera. Not everything low is unattractive.

About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.

Post Updated 7/11/2014.

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Ryan says

    Hi Sam, correct me if I’m wrong, but don’t you get the earnings after the CD has matured? I know you talked about passive income for the CD’s each month. Sorry, not that familiar with CD’s. Thanks – Ryan

    • says

      You do indeed. You can also choose to have the interest sent to your checking account or any account as the CD matures to spend as you wish without penalty.

      If you have a $100,000, 7 year CD for example at 2.5%, you can spend $2,500 a year of it no penalties. I just choose to reinvest it back in the CD.

      Double check your terms as always.

  2. says

    The current rates at ING Direct for a 5-year GIC (which I believe is similar to a CD for you guys) at 2.3%. Not a great rate, but you make a good point about the markets being volatile, and thus not very suitable if you’re looking for income and net worth preservation in the short to medium term.

  3. says

    Great post, I recently did a CD ladder post, and I do agree with you that everybody should have CD’s to diversify the risk with all the stock investing we do in 401K’s, IRA’s, and individual stocks. How much was the amount of the first CD you did? Is that your Car? Also how did you actually negotiate with the bank to allow you to withdraw the CD penalty free?

  4. says

    I don’t blame you at all for wanting to diversify by having 30% of your money invested into CD’s. I call that being smart. Yes the rates are low, but like you said, they are better than the rates of a money market, and they are guaranteed. I’m currently not invested in any CD’s because we are using that money to pay down debt. Once our debt is gone (thinking 5-6 years) I want to start building a CD portfolio with the goal of being able to live off of when I retire. Everything else would just be extra.

    • says

      Thanks. Yes, definitely attack that debt with the majority of your savings given I’m sure the debt costs more than 1.73-2.3% (highest rates I’ve seen for the longest duration currently).

  5. David M says

    “Accrued interest is accessible. In the event that I no longer have income and no longer have any savings, all the accrued interest earned from my CDs can be withdrawn and used penalty free.” I never knew that – great to know. I thought you had to wait until you got your principle back – I guess also did/do as “Ryan” asked about this.

    I have over $200,000 in I bonds purchased over 10 years ago bringing in 4% – 6% currently – I’m loving that return!!!

    I also have about $50,000 in a money market account getting only .4 of 1% – however, like you said – “I’m not greedy” – I’m happy to have that cash readily available “Just in case”.

    With extra cash – I’m going to continue to prepay my mortgage – as well as invest in stocks.

    • says

      Yep, just ask your bank for details. I have CDs with several of the major banks aswell as USAA as well online, and they all allow me to access my accrued interest penalty free.

      Nice job on the ibond! LOVE THAT! I’ve got the same with two 4.1% CDs with still 3 years of maturity left to go. Set it and forget it.

      • David M says

        Thanks regarding the Ibonds. Yes I have 20 more years on most of them that I can as you said “set it and forget it”

        I will admit – when the were getting no interest for a 6 month period in 2008 – I cashed in $30,000 worth and put that money towards the principle of my mortgage. Was that a good decision – absolutely NOT. However, in the long run – not a big deal. I just want to not make that BAD decision again the next time the interest payment go to zero for a 6 montsh period!!!!!

  6. says

    First off nice Porsche, love that color! I agree that having some guaranteed income is better than risking it all and losing by 5%. Seems like you have a lot figured out and the money to do it. I this point I am working on the nut. The plan is in order but still getting the money up. I didn’t know you purchased FB… I was thinking it was going to drop to about 20$ before I would pull the trigger but it didnt and I refuse to buy it now. Whats your price point to sell off?

    • says

      Yeah man, it’s all about building the NUT! Once you build the nut to live off, you don’t want to do anything to shrink that nut b/c it is so valuable!

      I bought 700 shares of FB at a blended price of $27. Will probably sell 300, and just let the rest ride. Based on my post, I’m bullish.

  7. says

    Personally, I do not like CDs because you are locking up an interest rate for years. I expect interest rates will be higher a couple years from now. I understand the need for diversification and passive income, but dividends are treated better for taxes. Just a different viewpoint!

    • says

      No problem. In today’s like today, with the markets crashing, I’m reminded again why I love CDs!

      Dividend taxation treatment definitely is better, and I do have dividends as one of my income streams.

  8. says

    Sam, I have not invested in a CD since I was in high school, which was over 20 years ago. Once I learned about bonds and stocks I did not look back. I own some mutual funds that invest in debt securities overseas and have been very happy (currently yielding 4.5%) the return has easily trump the overall market. In addition, I own quality companies that pay dividends every year and also raise them…they are out there, but one must tread carefully…During the 08/09 collapse…even my dividend stocks got it.

    Joe

    • says

      Ahh, I would have loved to invest all my money in Microsoft then! Alas, I had no real money 20 years ago.

      On days like today, with the Dow down 170 points as of 10am PST, I love my CDs. Steady eddy and diversified.

  9. Chris says

    Wow, nice Sam! Having roughly that much cash in CDs, throwing off $2,800/month, can assuredly let one sleep a lot more comfortably!

  10. says

    Glad that you’re interested in protecting prinicipal with a portion of your income – I’m investing a bit now, but I’d like to move into more stable investments as I get older. I could probably live off of your CD interest!

    • says

      Always interested in protect principal Jeff, especially the bigger the principal grows!

      The question is, could you and your wife and child live off my CD interest? Unlikely, happily, hence why I gotta keep growing the nut!

  11. says

    I had $60k in CD’s at one point, rockin’ something like 5% at age 18! Unfortunately, I had a contingency on the account and was able to withdraw all of the money pensalty-free. I spent every last penny. :(

  12. says

    Since we are only starting to build up our financial portfolio, we cannot afford to put 30% of our net worth in CD, much more in 10-year term. We just started investing in CD a couple of months back on a 2-year term. We hope to make another one before the year ends and in a longer term. You just inspired me to create a CD investment in 10-year term. Thank you for sharing!

  13. says

    You make a compelling argument for CDs. While I think you make a strong case for your CD investments, I wouldn’t recommend it to everybody.

    Most people that I come across “invest” 100% of their savings in CDs which I find baffling. Considering CDs have produced a negative real return 8 of the last 15 years, it’s contradictory to say that it’s a way to “not lose money.” (Of course – I’m assuming this statistic used whatever a 1 year CD was averaging). Once you’re in your later years, I understand the need for preservation but I get frustrated when I see a 25 year old investing in CDs.

    You actually touched on one thing I was going to bring up. CDs (to me) are fine if they aren’t your only investments. You have real estate, you have online income, you have a diverse source of cash flow that most people don’t have. The time/money spent here is absolutely an investment that has some risk but also amazing potential returns.

    With these mega returns you’re getting elsewhere, it’s fine to have 30% of your dough in CDs.

    • says

      Abe, people get caught up in “negative real return”. Would you rather be up 32% in the past 7 years on a 7 year CD yielding 4%, or up 5-10% with the market?

      Most people I come across invest 100% of their savings in the stock market, which I find baffling. I know only a small minority of people who invest the majority of savings into CDs.

      • says

        I suppose my views are biased since the “majority of people” I speak of were actually sitting in a bank branch when I was speaking to them.

      • Investor Junkie says

        I disagree, I think most DON’T understand a real negative real return. Especially people who invest in CDs who are typically not that financially savvy. Most don’t take inflation into consideration and is the reason why it’s called the “hidden tax”. If you understand this and still invest in CDs then that’s fine by me.

        • says

          Maybe. What is your asset allocation? Are you saying you’ve invested most of your savings and net worth in the stock market over the past 10 years? If so, how has that done for you?

          I think it is way too risky for people to invest more than 50% of their net worth in the markets, no matter what age. Obviously, the older the more risky. Think about people who wanted to retire between 2005-2015.

        • Investor Junkie says

          Less than 50% in the stock market? If you are near retirement yes. You are stuck on the recency effect. Stock market (besides owning your own business) is the best way to get wealthy. Rentals counts as a biz. It all depends if you are biz owner or a employee. If you have the employee mentality then you should be more than 50%.

          Are you counting primary residence? I don’t think it should be counted.

          If not just including our retirement accounts we are at 60% AA for stocks. I’m not sure what that would be with all of our investments. Maybe at 50% number maybe slightly less if you include all investments. Our retirement accounts
          are about 1/3 of our total NW.

          If the money is for retirement 20-30 years away you most definitely should be higher than
          50%. The statistics show you should be above this.

        • Investor Junkie says

          I’m thinking just specifically my retirement accounts when I first read your post, but I guess you are right.

  14. says

    Quick question Sam – What would be the min. to allocated in cd ladders to make it worth while? I mean when you are trying to get to that point would you start off with 5k-10k in cds? Also how to you feel about those P2P lending sites?

    Almost forgot hows the new biz going for you(online services)?

    • says

      I started off with $5,000, then slowly built the amounts over the next 13 years. It really depends on how attractive the relative rate is compared to the risk free rate and the economic scenario. The point is to just start, and put money in consistently EVERY year.

      After the initial grace period of say 5-7 years, you will have new month come due every single year. It’s the thesis to The DVD Method To CD investing.

      FSOS is going well! I’ve had to put clients on hold b/c I want to finish my book!

  15. Jerry Curl says

    One of the biggest cons over the past decade is financial advisers getting retail people way into stocks and various funds for the fees.

    Like you said Sam, a CD invested 7 years ago at 4% has provided over a 30% return. Compare that to stocks, property, and that is a great figure! If I only invested everything in gold…

  16. says

    Sam, I just updated my CD rate sheets today and noticed several CDs paying greater than 2%. There are three GE Capital Bank CDs (6, 7, 10 year) paying 2, 2.15 and 2.65% respectively. The YTW is slightly higher.

  17. Allyson says

    I’m a big fan of Ally Bank CD’s. I have 12 one-year CD’s, one for every month of the year, each maturing on the first of the month. I just started this plan a year ago, so the amounts in the individual CD’s are pretty small, but the goal is for them to be rolled over every year, adding $100 each time, and for them to eventually be $1200, which is the amount of my mortgage payment. So I could make the full mortgage payment on time every month for a year. I have an alert on my phone on the first day of every month, reminding me to call. You get a .25% rate increase over the current rate when you renew a CD as a “loyalty reward,” so I’m getting more than the market rate for a 12-month term every time I renew. I realize this is an unconventional way to structure an emergency fund, and some people might think it’s too much hassle, but I like the peace of mind in knowing that in the event of a job loss or disability, the roof over my family’s head is safe for a year. Disability payments or unemployment, as well as our regular savings, could go to other bills. If no catastrophe ever strikes, I can simply cash in a CD once a month towards the tail end of my mortgage and pre-pay it.

  18. mox says

    hello, im a total novice about cd investing and could use a little help. I am gettting a 100,000 settelment from a lawsuit and would like to know how to invest it to get a montly income. any ideas?

  19. smith apple cake says

    i am doing the same i am banking with barclays banking i invested 25 million into a 5 year term of 2.25% comp daliy more then one account i was setting up accounts with ally banking and they told me they will never open a account up for the life span of my life i was blown away crazy people omg so i asked why they told me i was located in mo but there system was telling them i was in cali state odd ally banking system i do not recommend ally i would liked to bank with them but they acted odd with me please help me out on that one thanks ow and i am the cheapest person alive

  20. Axiumph says

    Correct me if I’m wrong, I’m just a college student, but don’t you have to take into account inflation? If you invest in a 1.6% CD and inflation is 2%, aren’t you actually losing 0.4% every year? Why would you ever want to do that? Aren’t there better inflation-resistant investments you can make?

  21. Neyo says

    Hey Sam,

    How do you even start a CD investment?

    Can you guide me through in steps? It would really help me out!

    Thanks,
    Neyo

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